..
THE SEC, THE BANKS
AND THE CAPITAL MARKETS
Remarks by
ALAN F. BLANCHARD
EXECUTIVE DIRECTORU. S. SECURITIES AND EXCHANGE COMMISSION
CARTER GOLEMBE ASSOCIATES EXECUTIVE SEMINAR
October 16, 1975
THE SEC, THE BANKS AND THE CAPITAL MARKETS
Remarks by
Alan F. B1anchard*
I was interested to note that mine is the only talk on your program
with no title. That probably is appropriate. The overall Conference
topic is "regulation," and my mere presence is probably as eloquent a
statement on the regulation of banks as anything I can say. If an economic
Rip Van Winkle were to come upon this scene, I think he would be very
surprised to see a Securities and Exchange Commission official addressing
a bankers conference. He would probably conclude that "something" had
changed, and that that "something" had to do with regulation. Finally, he
probably would decide that it does not mean that there is less of it.
I think that our Commission today looks quite different to its
historical clients, the brokers and investment advisers, than it does to
the banks. To its historical clients, and to government in general, the
Commission is in something of a deregulation mode. The unfixing of
commission rates on securities transactions was an historic and phenom-
enal event in terms of voluntary deregulation by a governmental agency.
Other less dramatic steps have also helped make the Commission, at least
to the government, one of "the deregulatory "good guys." From your per-
spective, however, I suspect that the Commission is like a very large
camel who is suddenly in your tent up to its second hump.
* The Securities and Exchange Commission, as a matter of policy, dis-claims responsibility for any private publication or speech by anyof its members or employees. The views expressed here are my ownand do not necessarily reflect the views of the Commission or of theCommissioners.
2
Given all that is going on, there is quite a lot that I could talk
about today. I would like to touch very briefly on the recent actions
the Commission has taken affecting banks and then spend the rest of my
time on some of the basic conceptual and philosophical questions that I
think the Commission will be wrestling with in the years ahead.
In summary, I am going to try to support three basic points. The
first is that the major actions the Commission has taken over the last
year or two affecting banks follow logically from its traditional regulatory
purposes: for example, municipal bond regulation, and transfer agent and
depository regulation can be viewed as facilitating fair and orderly mar-
kets. The Commission's increased involvement in bank holding company
disclosure requirements is natural given its re~ponsibi1ity for full
disclosure and particularly important given increased investor interest
in bank stocks.
My second point relates to what I think is going to be one of the
major issues in the future: the concept of "making the capital markets
work. II We all know that major changes have occurred in the functioning
of the securities market over the recent years. I think that a review
of the major market changes indicates an increase in the importance of
the banks to the effective working of the securities markets. This
change is another cause of our increased involvement.
My final point relates to what I have given the tongue twisting title
of "increased inter-financial intermediary competition." Competition
3
among financial intermediaries is increasing. and I believe that this
makes the question of the strengths and weaknesses and ~elative competitive
position of each group far more important. Since the financial inter-
mediaries ~re all highly regulated, the attitudes of their regulators
is a particularly important aspect of their competitive position.
Let me .try to develop each of these thoughts.
BANKS AND THE COMMISSION'S REGULATORY PURPOSES
I think that the best way to develop a frame of reference for looking
at the Commission and the banks is to examine recent events in the context
of the Commission's basic regulatory purposes. Most students of govern-
ment would agree that the Commission has two, or perhaps three. regulatory
purposes, such as the ones I have listed on Exhibit I (following this page).
The first is helping to facilitate fair and orderly capital markets; the
second, insuring full disclosure to investors. I think that the Commission's
mandate in these two areas is relatively uncontroversial. However, I have
put a question mark by What I listed as a third purpose to facilitate
effective capital markets.- As I will later indicate, what that means
and what the Commission's role should be is widely contested.
From your point of view. the important fact is that, under each of
these purposes, there have been a number of Commission activities over
the last year or so which very much involve the banks. I have summarized
them on the right-hand side of the exhibit. In the" fair and orderly
capital markets" area, there have been municipal bond regulation and
-
RECENT SEC REGULATORY EFFORTS AFFECTING BANKS
REGULATORY PURPOSE SEC ACTION / DISCUSSION
Fair and Orderly Capital Markets
Full Disclosure to Investors
Effective Capital Markets (7)
3 A
Municipal Bond Requlatron
Transfer Agent and Depository Regulation
Bank Holding Company Disclosure
The Bank Study
The New Agency Debate
4
transfer agent and depository regulation; in full disclosure, bank holding
disclosure. Against effective capital markets, there has been the bank
study and something I will explain further which I have called the new
agency debate.
FACILITATING FAIR ANDORDERLY MARKETS
I think I can deal quite quickly with the fair and orderly markets
issues. While each of them is a major expansion of Commission responsi-
bi1ities and operationally very ~portant to you, their content is relatively
straightforward.
Transfer Agent Regulation
With regard to transfer agent regulation, all I want to do is to point
out that the context in which authority over bank transfer agents was granted
was that of the overriding objective the Congress has laid down of stream-
lining the securities transactions process. This is evident if you look at
the "findings" section of the 1975 Act Amendments which gave the Commission
this authority. The Congress found that:
the prompt and accurate clearance and settlement of securitiestransactions, including the transfer of record ownership andsafeguarding of securities and fund related hereto are necessaryfor the protection of investors •••
(B) Inefficient procedures •.• impose unnecessary costs;
(C) New data processing and communications techniquescreate the opportunity for more efficient, effective,and safe procedures ••.
5
(D) The linking of clearance and settlement facilitiesdevelopment upon standards •.• will reduce unnecessarycosts, •••
(2) The Commission is directed, therefore, having dueregard for the public interest, the protection ofinvestors, the safeguarding of securities and funds,and the maintenance of fair competition among brokersand dealers, clearing agencies and transfer agencies,to use its authority under this title to facilitatethe establishment of a national system for the promptand'accurate clearance and settlement of transactionsin securities.
The way this relates to you, of course. is that the transfer agent is
the one guy in this process over whom the Commission has had no real authority,
until this legislation. Initial Commission responsibilities here are to work
out a system of registration for transfer agents with the bank regulators
and then to try to establish SOme rules Which are helpful but not burdensome,
a process which is just beginning. If you want to know more about it, I
recommend a recent speech by Commissioner John Evans. entitled "Transfer
Agents Meet the SEC.II
Municipal Bond Regulation
Municipal bond regulation is a major new responsibility. Again, how-
ever, I suspect that you are sufficiently familiar with it that I need not
say much about its substance. What has happened here is that the basic
Commission authority has been extended to a whole new marketplace; one
which is very close to you. You are, I am sure, familiar with the abusesthat resulted in the Commission's being given this authority.
6
I think that from your point of view, the greatest hope for sensible
regulation is for the new Municipal Securities Rule Making Board to get
involved deeply enough so that the private sector does relatively more
in this area and the Commission relatively less.
As you know there are five bankers on the Rule Making Board. They
are:
Richard F. Kezer, Senior Vice PresidentFirst National City Bank
Bert C. Madden, Senior Vice PresidentTrust Company Bank of Atlanta
Frank K. Spinner, Senior Vice PresidentFirst National Bank, St. Louis
David G. Taylor, Executive Vice PresidentContinental Illinois National Bank and Trust Company
John R. Valla, Vice PresidentInvestment Banking Group, Bank of America, San Francisco
The Commission is impressed and encouraged by the professionalism of the
first steps taken by this group. The Commission's initial efforts will be
working on the registration of municipal dealers and resolving the questions
of when a bank itself must register and when it can be said that the bank
has a separately identifiable municipal department.
ACHIEVING FULLDISCLOSURE
Bank holding company disclosure is the current Commission activity in which
I suspect you have the greatest interest, since it vitally affects those of
CASH OFFERINGS BY BANKS HAVE INCREASED SUBSTANTIALLY
Bank OffenngScale
(billions)
Total OfferingScale
(billions)
$4
$3
$2
$1
BANK CASH OFFERINGS-4---- Scale
TOTAL CASH OFFERINGS/ Scal e c-s-e-: $40
$30
$20
$10
1970 1971 1972
6 A
1973 1974
~
7
you who; one, are holding companies subject to Commission jurisdiction;
and two, are thinking about going to the capital markets for funds.
And, I should point out that the number of you who have these two characteris-
tics has ri~en substantially over the last five years. Exhibit 2
compares the cash offerings of bank holding companies with the total
cash offerings in the market, for each of the past five years. You will
see that bank holding company offerings have gone from $132 million (a
total of 26 offerings) in 1970 to $2.86 billion (a total of 130 offerings)
in 1974. During the same period, total cash offerings oscillated around
the $38 billion level. This means that the banks have gone from less than
one half percent of capital raised to over 7 percent; their market share,
therefore, has increased 14 fold.
The History of Commission Involvement
The Commission's recent involvement in this area began when a number
of the accounting firms that audited banks expressed some concerns about
the adequacy of disclosure, particularly disclosure of risk loan portfolios.
The result was a great deal of study and discussion with the bank regulators
and the recently released ~roposed guide for disclosure by bank holding
companies.
The Commission staff worked quite closely with the bank regulators
in an effor~ to make the disclosure called for in most of the areas similar
to the figures reported to the bank regulators. For this reason, I
think that much of the information asked for will not be troublesome. How-
8
ever, major questions remain in two areas as highlighted in the release.
Loan Portfolio Issues
The guide discusses three alternative approaches to disclosing
information in two important loan areas: "non-performing loans" and
"additional high-risk loans." For "non-performing loans," each alterna-
tive requires some disclosure of loans which, "are contractually past due
60 days or more as to interest and principal payments," or, "the terms
of which have been renegotiated to provide a reduction or deferral of
interest or principal." While all the alternatives require disclosure
of the interest income lost, two require disclosure of the aggregate
amount of loans in the category as well. The release asks that you
comment on these two options.
For "additional high risk loans," two alternatives establish a category
called "loans involving reasonable probability of non collectivity."
These are defined as loans which, "in management's opinion, involve a
reasonable probability that principal and interest, in whole or in part,
may not be collectable." One alternative again requires disclosing both
interest payments lost on these loans and their aggregate amount; the
second requires disclosing only the aggregate amount.
The third alternative defines these additional risky loans more
narrowly. This alternative creates a category called "loans involving
expected losses" which are, "those outstanding loans which management
9
has taken specific account of in computing its provision for loan loss
reserves because of expected loss in whole or in part." In this case,
both the aggregate amount of the loans and the interest lost must be
disclosed ..
Foreign Banking Operations
The guide also calls for a certain amount of disclosure of foreign
banking operations, and comments are specifically requested on how foreign
banking operations should be defined. Should they be "business transacted
through foreign branches" or "business with foreign obligors or depositors
whether through foreign branches or not" or something fundamentally different?
In both of these areas, I think that your comments would be very
helpful. Comments are also requested on the cost of compliance; if you
have strong points of view on this topic, please make them known as well.
Increased Bank Stock Activity
If you are like most of the people with whom I have discussed this
topic, I suspect you have a somewhat ambivalent reaction at this point.
You are not really against "full disclosure" or "fair and orderly markets";
in fact, you are for them. And, however reluctantly, you probably will
concede that the Commission has contributed to the historically outstandingsuccess of the United States capital markets. At the same time, all of
this new regulation probably sounds like an incredible administrative burden.
THE VOLUME OF BANK STOCK TRADING IS UP SUBSTANTIALLY
3.0
SELECTED BANK STOCKS
ALL NEW YORK STOCKS....- -- ....................
VearlyVolume
Divided by 2.0\910 Volume
1.01970 1911 1972 1973 197 ..
BANK STOCKS HAVE BECOME MORE VOLATILE
"'",e,"25
20
Ab.ol"teVol". ofP.reentChange 15'rom
(:Ir.VIO".year
10
1969 1970 1971
9 A
1972 1973 1974
__ _ _ _ _ ~
~
-
10
I don't really propose to try to talk you out of that feeling, because I
think your arguments reg~rding the burden and practicality of the things
the Commission does are valid. If you have such concerns. you should make
them known in the most forceful way possible.
I do want to make one additional observation, which may further
help explain Why this topic has become such a hot one. That is, bank
stocks have become a lot more important to investors over the last five
years. Let me show you this in a couple of ways.
First, the trading in at least some bank stocks has increased
substantially. Exhibit 3 compares the trading in five major New York
banks with all New York Stock Exchange stocks. Trading in New York
bank stocks has increased about three-fold, from 12.7 million shares to
35.9 million shares over a five-year period. Over the same period,
overall New York Stock Exchange trading has gone up only 18 percent (from
3.2 to 3.8 billion shares) so that the banks' percentage of trading has
gone from 0.4 percent to 0.9 percent.
Secondly, the bank stocks appear to become considerably more volatile.
This is evident by comparing the Moody's Composite Index and the Moody's
Bank Stock Index, both of Which measure percentage change in value from
one to the next year, as shown on Exhibit 4.
This chart shows the absolute value of percentage changes in stocks
so, unfortunately, it does not indicate that there has been only positive
11
stock movement over the past years. But you can see by comparing the
shaded bars (the banks) with the solid bars (the stock composite) that
from 1969 to 1971 the movement of bank stocks was very small compared
with the movement of the market overall. In 1970, for example. when
the market was down 14 percent, bank stocks were down only 2.4 percent.
In 1971, the market recovered and rose 15 percent, while bank stocks
rose only 4.8 percent. But in 1972 and 1973. the movement of bank stocks
was far greater than the movement of the market. The market was up 11
percent in '72 and the banks up 24 percent. In 1973, the market was
down 2 percent and the banks were up 13 percent. In 1974, when the
market dropped a little over 20 percent, the banks almost matched the
drop.
What these two factors more new issues and increased price volatil-
ity mean is that investors have a great deal more at stake in bank
stocks than they did before. I think this adds to the sense of urgency
of disclosing bank economics accurately to investors.,
So much for the Commission's major activities involving banks and
the reasons for them. I would like to move now into a much less
precise area those activities which seem to derive from what I contended
was the Commission's third role.
-
-
-
12FACILITATING EFFECTIVE CAPITAL MARKETS
Facilitating effective capital markets is a much more controversial
purpose for the Commission; in fact, many Commission staff members argue
vehemently that the Commission has no role at all in this area. But
it is an indisputable fact that the agency is devoting a lot more
attention to the question of capital market function; this appears consistent
with the increased government-wide and country-wide concern with economics.finance, and the capital markets.
I suggested that the Commission has been involved in two specific
activities relating to this objective which relate to the banks: the
bank study and the new agency debate. Let me consider the first briefly
and then introduce the second by talking briefly of some fundamental
changes in the marketplace.
THE BANKSTUDY
The Commission's bank study is one of two such studies which are
currently being conducted. The other is planned by the Senate Banking
Committee; you may have seen their 42-page outline. 'TIleCommission
has set up a task force to work on what its study is going to encompass
but it is still too early to say precisely what the study will look at
or what migbt be concluded. So what I would like to consider is the question
of why all this activity is going on. Why is there suddenly all this
interest in the banks and the capital markets?
TRENDS CONCERNING BROKERS
1. Institutional ization of the market
2. Unfixing of comrmsston rates
3. The capital shortage
4. Increased inter-intermediary competitions
12 A
IMPORTANCE OF BANKS
Banks control more business
Banks market power unleashed
Banks are going to demand capital
Banks are more Important to corporations
Banks are huge
Economic environment IS more favorable
Bank regulators are more supportive
•
•
•
•
•
•
•
13
One of the simplest reasons, I think, is that in most discussions,
as soon as you start talking about capital markets, SOme one says,
"You better look at the banks." If it is a broker talking, he goes on
to say, "The banks are going to put us out of business, and that is
bad." And I think exploring why brokers say this might yield some
insights on the kinds of questions that will arise in the various bank
studies and on the kind of things I think you will want to think aboutas you participate in this debate.
THE MAJORMARKET CHANGES
It seems to me that what is really happening is that a lot of
changes are occurring in the capital markets. Like almost all changes,
these make participants in the process uncomfortable. More specifically,
I think that a number of them do happen to involve the banks, and a lot
of them do appear to increase the power of the banks. have listed on
Exhibit 5 the four major trends which seem to be of greatest concern to
the brokerage industry. They are: the institutionalization of the market,
the unfixing of commission rates, the capital shortage, and increased
inter-intermediary competition.
I will discuss what I mean by each of these in a moment. The key
point for today's discussion, I think, is that one of the effects of
each change, at least superficially, can be argued as increasing the
influence of the banks in the capital markets. I have listed the
aspects of each trend which appear to increase bank power on the right-
~
STOCK HOLDINGS UNDER BANK INFLUENCE HAVE INCREASED SUBSTANTIALLY
COMMON STOCK HOLDINGS($ BILLIONS)
1967 1973'/c
CHANGE
Bank Influenced Investors
Other Institutional Investors
Ind ivrduals
$ 157.9
$ 69.9
$ 567.9
13 A
$ 239.2
$ 87.8
$ 550.6
+51%
+ 26%
3%-
14
hand side of Exhibit 5. I will discuss each of them as we look verybriefly at the trend ilself.
Market Institutionalization
Institutionalization of the market, my first major trend, is so
widely discussed that we do not have to spend much time defining it. As
you know, commission brokerage fees make up 52 to'65 percent of New York
Stock Exchange member finn revenues each year. What market institution-
alization has meant to the brokers is that the identity of the customerthat generates that revenue has shifted dramatically. New York Stock
Exchange trading has flipped-flopped from 35 percent institutional, and
65 percent individual to exactly the opposite over the last ten years.
This is primarily because the holdings of institutions have increased
substantially. I have rearranged some Commission data on equity holding to
break out what it seems to me you can call "bank influenced" investors versus
other institutional investors and individuals. As shown on Exhibit 6, I
calculate that the holdings of bank influenced investors have grown from
$157 billion in 1967 to $239 billion in 1973. (I have included non-insured
pensions, -personal trusts, state and local retirement funds, foundation
endowments and educational endowment funds in this group. Obviously, banks
do not control every penny of this money, but the magnitude of these numbersappears consistent with ABA estimates that bank trust fund assets have gone
from $275 billion to $400 billion from 1968 to 1975).
The other institutions, primarily mutual funds and insurance companies,
are quite small in comparison and their growth has been no where near
as rapid. ~ndividuals, the largest single group, have decreased in size;
and, as you know, the trading rate of individuals is considerably lower
than that of the other groups.
All of this means that banks have become far more powerful as
consumers of brokerage business. Combined with the statistics looked
at so far, it is fair to say that banks are a large and growing component
of market activity and that they have considerably more influnce than
they did ten years ago.
The Unfixing of Rates
The second major change, which is closely related to the first,
~s the unfixing of commission rates. As you know, the government has
forced a very dramatic change on the brokerage industry through the
unfixing of rates. The pricing decision is one of the most difficult
decisions to be made in any business, and for 190 years the brokers
did not have to make it. Over that period, the brokers whole method
of operation has been based on assuming prices are fixed and adjusting
services, merchandising and other elements of their business to provide
effective non-price competition.
In terms of today's topic, the unfixing of rates mean that given
their size and great importance as customers, the banks are now in a
15
16
position to do some very tough negotiating regarding what they pay for
the service they receive. The potential market power that comes from
the size and growth rates already discussed are unleashed. Before. with
no latitude to negotiate about price, the relative size of the seller
of the service (the broker) and the purchaser of the service (the bank)
had far less importance. The ability to negotiate does seem to make
a difference, since institutional rates have gone down about 30 percent.
This may not just be because of bank "power," but you will have trouble
convincing the brokers of that.
The Capital Shortage
The third major trend, I think, is the capital shortage.
There is no disagreement between banks and brokers as to the existence
of a capital shortage. The New York Stock Exchange has suggested that
there will be a $600 billion shortfall over the next 10 years. Chase
Bank has been running ads with titles like itATime to Cry WolL" The
big question this raises with the brokers, I think, is what the future
capital markets will look like, and who will play what role in the under-
writing activity of the future. This is a very important question
to the brokerage community, since the broker's major source of income
after commission revenues is underwriting, which makes up 10 15 percent
of total income each year.
The relative importance of brokers and banks as suppliers of
funds to corporations already has changed significantly, over the past
-
BANKS HAVE SURPASSED BROKERS IN PROVIDING CORPORATE FUNDS
$36.6
$34.6
Corporate$19.8 $18.8
Bonds
/'/'
/'/'
/'
BankLoans $5.6 $4"
1970 1971
$53.9
"'.1
$47.2 /'
'"'"$7.4 '"'" $19.7
//
$9.2/
// - --
/ I/
II
I/
I$30.6 $30.1
197419731972
$10.9
$12.2
I
'"
$13.5
$n."$507
$31.1
CorporateSlock
16 A
-
17
five years. Exhibit 7 shows the size for each of five years of the threemajor external sources of funds: bank loans, corporate bonds, and corporate
stocks. You see that bank loans have grown significantly; absolutely,
they have g~ne from $5 billion to $30 billion: as a percentage of the
total, they have grown fram about 15 percent to over 50 percent.
If a capital shortage of anything like the dimensions being discussed
develops, the problem of the securities firms' role as underwriters will almost
certainly become far worse. The equity markets may very well dry up for a
large number of companies, and bank credit will become even more important.
This means that those companies which are looking for types of financing
which either the banks or the brokers can provide for them, for example
private placements, may well feel they have to go to the banks, because
of the importance of retaining their good will. This could result in the
situation which I think was very accurately described by Otto Eckstein, former
Chairman of the Council of Economic Advisors, in a statement prepared for
the Economic Summit Conference in the fall of 1974. He said:
More fundamentally, a healthy capital marketpromotes the competitiveness of the Americaneconomy. If the current stock market situationwere to persist, there would be increased concen-tration of the economy. The largest companiestend to be the most credit worthy and have theability to stand at the head of the line at thelending windows of the large commercial banks.The banks would become as powerful as they are in-Europe and Japan.
18
A NEW AGENCY TO MAKE INCREASED COMPETITION FAIR
I have very briefly reviewed three of the trends which I think have
made the brokers increasingly nervous about the banks: institutionalization ,
unfixed rates and the capital shortage. The final trend I showed on my slide
was increased "inter-intermediary competition"; I would like to spend
a minute on this one for two reasons. First, I think that, in a way, this is
the one that makes all the others so scary. Second, I think that this is
the trend which has led to the "new agency" debate which I initially
suggested as the final Commission activity affecting the banks.
We are all aware that the traditional lines between the various
classes of financial intermediaries have blurred substantially over the
past years. Restrictions on services offered have lessened, and many
aggressive financial service firms are constantly searching for ways to
take business from the other guy.
I think that the brokers feel particularly vulnerable relative to
banks in the newer, more open, competition. The trends discussed above
are part of the reason for this. Let me quickly cite three other elements
which I think concern the brokers: first, the banks are huge; second, their
economic environment is more favorable; and third, the brokers view
their regulators as more supportive. Reviewing these concerns will lead
logically to my final topic, the new agency debate.
BACHE
AND IN EMPLOYEES
1000
BOO
600
BANK HOLDING COMPANIES DWARF THE BROKERAGE INDUSTRY IN STOCKHOLDERS EQUITY
BROKERS
Stoc kholder ..EqUlh
($: B,llIons
22 l20 l18
lI
16 l14 --;
i12 -i
II
10 I-,
Il
il
!
1 E F Hutton
"""'"MeITII Lynch
sn Hanko. wllhi.,,,eu/l'c;l eqluh
All tJYSE MelT'Der5 CarryingP\i)hc A.cCOl"l'lts
$321""---- --- -- - - --.,, 'iubudmaJrll Deb'
123
18 A
J
19
THE SIZE OFTHE BANKS
One could argue that any simple compari~on of the size of brokers
and banks is not really fair, because of the tremendous differences
in the service mix of the two industries. But I think that the "David
and Goliath". phenomenon is a little scary to the David, even if not
all the resources of the big guy are devoted to fighting him. Obviously
there are a lot more banks than there are brokers; roughly 14,000 versus
4,000. Accordingly, it is not surprising that the brokers people resources
are considerably smaller than the banks. The left hand side of Exhibit 8
depicts Merrill Lynch with about 20,000 employees and Bache with 5,000.
The 25,000 employees of those two largest brokers are considerably smaller
than Citibank's 41,000 employees. And the total staff of the two brokers
is only a third the number of employees of Citibank and Bank of America
combined, which is 75,000. The disparity continues to apply when you look at
the industries overall; the brokerage industry has about 180,000 employees,
while the banks have over a million.
In the current environment, the availability of capital resources
may be even more important than the availability of people; and comparison
of the equity resources of the two industries is even more dramatic than the
people resources. The left-hand side of Exhibit 9 shows the broker capital:
Merrill Lyn~h has about $500 million of equity (these are 1974 figures);Bache and E.F. Hutton raise the total for the largest three to about
$670 million. The rest of the New York Stock Exchange member firms carrying
public accounts, which are by far the largest firms in the industry, raise
FAILURES ARE FEWER
1970 1971 1972 1973 1974
BANKS
Total FDIC Banks 14,199 14,294 14,436 14,676 14,968
Number closed forfinancial reasons 8 6 3 6 4
BROKERS
Total SIPC Brokers
Number closed forfinancial reasons
* Data not available
* 3,994
24
19 A
3,756
40
3,974
30
4,238
15
the total to $2.3 billion in equity. Adding their "subordinated debt,"
an unusual form of capital, raises the industry figure to $3.2 billion.
In contrast, Citicorp's $2.2 billion is almost as large as the
equity of the New York Stock Exchange member firms overall. Citicorp
and Chase, with a total of $4 billion in equity, are considerably larger
than the equity and subordinated debt of all New York Stock Exchange
firms: And if you look at the 50 largest banks, you get an equi ty figure
seven times that of the brokerage community. Based on this, it is not
hard to understand why competition looks a little rough.
BANKS EASIERENVIRONMENT
There is a second argument Which we hear from the brokers so
frequently that it gets a bit repetitious. This argument is that the
banks operate in a far easier economic environment than the brokers.
To some extent this belief may just be based on a "grass is greener"
outlook; but if you look at the numbers, it does appear there is some
basis for this statement. Let me present three interesting facts; the
failure rate of banks is far lower than that of brokers, second, their
income appears to be far less volatile and, third, tax rates appear
to be more favorable.
The Rate of Failure
Exhibit 10 compares Federal Deposit Insurance Corporation
statistics on the number of banks closed for financial reasons with
20
Fed.rQI Reserve Member.
NYSE /:Members DOing
Business With the Public:
.
....//.'.....
.'......8%
12%
6%
10%
Net Earningsas a Percent atTotal InvestedCapItal
BANK EARNINGS ALSO ARE LESS VOLATILE
I
iII
I
III
......... .
.
2%
.'............
....
I72 73 1974
20 A
'"
~ ~
~
'
21
securities Investor Protection Corporation statistics on brokers closed
for the same reasons. Over the last five years. the FDIC has had an
annual average of 14,516 banks registered with it each year. The annual
number of failures has averaged 5.4 and aggregated 27 over the five
years. The aggregate number of fai1ures~ therefore, is less than two-tenths
of 1 percent. SIPC~ which is the brokerage equivalent of the FDIC,
has had an average of 3,990 brokers registered with it in each of the
4 years since its creation. It has had an average of 27 failures a year,
or an aggregate of 109. In other words, the aggregate percentage of
brokers failed for financial reasons is 2.7 percent over the 4 year period.
This is a failure rate 14 times as high as that of the banks.
Stability of Earnings
It seems almost certain that one of the reasons for this difference
in the rate of failure of banks and brokers is the terrific difference
in the volatility of earnings experienced by the two communities. I have
attempted to illustrate these differences on Exhibit 11. This exhibit
should be viewed as showing patterns of change rather than absolute
levels, since developing the brokerage firm numbers require several
heroic assumptions. However, the pattern shown of the brokers is
essentially correct. The bank figures are fine; they come directly from
the Standard and Poor's survey.
The exhibit shows that the banks have an average annual after
tax return on total invested capital of 10.5 to 13 percent over a
five-year period. Over the same period, the brokers ranged from a
high of 15 to a low of 1 1/2. And the difference in the volatility is
incredible. The average annual percent change in after tax earnings
for the banks was 5.7 percent; for the brokers it is really striking
67.4 percent.
This kind of economic uncer t af.nty , makes the brokers planning
and competing very difficult.
Differing Tax Rates
The final point is the tax rate, and again, this is one about
which the brokers feel very strongly. Let me quickly suggest the basis
for the concern by showing some figures developed from the annual
reports on five major brokers and five major banks (Exhibit 12). It
appears that the effective tax rate, as a percentage of net income,
has been considerably lower over the last five years for banks than
for brokers.
There are a series of reasons for this difference. The major of
these is the significant municipal. state, and local debt instruments
held by banks. But, once again, to the broker it looks a bit unfair.
DIFFERENT REGULATORYPHILOSOPHY
We could argue for weeks about the accuracy and implications
of each of these comparisons. But I think most objective observers
would agree that, in aggregate, they do suggest that "something is
22
-
-
EFFECTIVE TAX RATE IS LOWER ON BANKS THAN BROKERS
\
\5 Major 8rok.r.
A.eragePercent ofNet Income
Paid InTox ••
30" 5 Molar 80nk.
20"
0% II I I I I I1970 71 72 73 74 1'75
22 A
~
23
different" when you look at the numbers on the two communities. Histori-
cally, it might have been explained simply by the fact that the businesses
were different. Banks were less riskYt more conservative less businessmen
than trustees of savings and assets. Brokers are more high f1ierst and
riskier entrepreneurs with earnings patterns more consistent with
a boom-and-bust approach to business.
But if the emerging public policy is to minimize the differences
between the two, take off the wraps and allow more competition, this
historical explanation is no longer sufficient. And in this context,
the final point I want to make is that many securities industry people
feel that one ~portant reason for the historically easier economic
environment of the banks is the difference in the regulatory attitude
which the government takes toward banks and brokers. Some brokers
believe that your regulators are more sympathetic towards your economic
conditionst and some also believe that this constitutes, unequal unfair
.regulation.
It is this perceived difference which led two years ago to the
suggestions for a new regulatory agency; and this is what I meant when
I referred on my first slide to the "new agency debate."
This debate really is not alive today partially because it never
generated much interest at the Commission. But I think some of the
points made in it are interesting and helpfu1t in thinking about the
appropriate focus of regulation in an environment of expanded competition.
-
-
24
I can highlight the major points of the debate by quoting some of
the comments made by the industry over its course.
As noted, the argument begins with the feeling that somehow the
Commission is fundamentally antagonistic towards brokers and, by extension,
towards the capital markets. One particularly articulate senior industry
official said:
The SEC because of the nature of its orgin and itslegislative mandate, feels quite properly that it mustassume the role of an adversary rather than an agencydedicated principally to the improvement of the nation'scapital markets.
Now, obviously, the commentator thought that this was the wrong
focus, and that the Commission should be more supportive. The proper
focus was suggested by the statement that:
The SEC should start with the premise that as amatter of national policy the capital markets ofthe United States must continue to be developedand improve; that broad public ownership of equitysecurities should be fostered; that the economicfunction of the securities industry must be pre-served and enhanced; that the securities industryshould consist of soundly capitalized independentunderwriters, marketmakers and brokers, whoseprimary obligation is to act as professionalsserving the public interest; and that all securitiesmarkets should be subject to comparable disclosureand regulation.
The brokers feel that other regulated industries have been dealt
with in a more supportive manner. The statement was made that:
Other industries imbued with similar essentialpublic interest characteristics operate understatutes designed to develop and improve thefunctioning of those industries. The commer-cial banking system for example, having beendetermined by Congress to be affected witha public interest, looks to Government agenciesto foster their growth and development. TheFederal Reserve Board and the Comptroller ofthe Currency seek to insure the solvency ofthe banks. Banks do not look upon their reg-ulators as adversaries.
At another point 1n the debate, one individual was, in fact, rude
enough to make specific reference to the differences.
In the area of preventing fraud, I can't helpbut compare the SEC's normal response to aWeis Securities or a duPont-Walston situation,in which the Commission is prone to charge outlike gangbusters, Whistles blowing shrilly, withthe Federal Reserve Board's measured reassuringcomments and actions in the recent Franklin'National Bank situation.
Now having reached this conclusion, some of the commentators were
led to question whether or not the Commission can change its spots. As
one said:
Let me hasten to say that I can see no wayfor the SEC to playa constructuve role in thesolutions of the problems that I have describeduntil it visualizes its principal role to bethat of improving the nation's capital markets,rather than as a constant adversary and criticof our corporate issuers and of our securitiesindustry.
25
..
This is the logic which leads to the suggestion that there is a need
for a new equity market regulatory agency. The same commentator then
said that:
To meet this problem, I would propose thecreation of a new Federal agency or publiccorporation to be called the Federal CapitalMarkets Board, whose five governors would befull time public m~bers appointed by thePresident of the United States with the ap-proval of the Congress for 10 year terms,similar to those of the Federal Reserve Board,and Which Board would report regularly toCongress.
My own private sector experience with commerical banks leads
me to believe you will be a little amused to find that others see your
regulators as such great benefactors. Again, it may be that all that
this argument is based on is the standard "grass is greener on the
other side of the fence" be lief. But it may also be that there are
differences in the objectives and focus of regulation which should be
explored. It seems to me that this debate raises fascinating questions
as to Whether fundamental changes are needed in regulation if the
battlefield of competition is to be fair.
SUMMARY
Now what to conclude from all of this? Again I apologize formy length. My problem is that I find the topic so fascinating. I
think three conclusions are evident:
26
0;
(1) The Commission has picked up responsibilityfor some involvement with day-to-day activity ofbanks through its traditional futl-disclosureand fair-and-orderly markets functions and thatbanks and the Commission will have to work togetherto try to make that involvement as effective andunburdensome as possible. I think the Commissionis sensitive to the danger of being overburdensome.
(2) I think that when you look at the broaderquestion of how the capital market works it isevident that the bankls role is increasinglyimportant and at least some people feel thereare fundamental differences in its objectivesand execution of regulation which should bestandard as relative roles of various financialintermediaries and the new capital markets emerge.
(3) All of this, I suspect, means that a lot ofattention will be given to these topics by allof us over the years ahead.
27
Thank you very much. I hope we can continue the dialogue.